This Could be the Perfect Biotech Portfolio

By: David Sterman

Posted: 7/11/2011 9:00:00 AM

Referenced Stocks: DNDN;IPF;ITMN;JAZZ;THLD

When it comes to biotech stocks, some investors like to swing
for the fences. When that plan works, it feels great. Shareholders
of
Dendreon (Nasdaq:
DNDN
)
, for example, saw their investment rise from $3 in March 2009 to
more than $20 in just two months. The stock has doubled again since
then, as well. But for every Dendreon, there are many biotech
stocks that flame out and end up in the waste bin.

This is why it's wise to take a diversified approach to biotech
stocks, owning risky stocks with lots of potential along with more
mature plays that are on a safe and solid growth path. I've found
four biotechs that run the gamut of the risk/reward spectrum. Taken
together, they constitute a model portfolio with considerable
upside -- if their respective drug development paths can stay on
course.

The high-risk/high-reward play

1. Threshold Pharmaceuticals (Nasdaq:
THLD
)
High-risk plays involve biotech firms that have drugs early in the
clinical trial process. Many hurdles need to be overcome before the
drugs ever hit the market, but the
market value
for these companies is often small in relation to the size of the
potential opportunity.

Threshold Pharmaceuticals is developing an innovative
hypoxia-activated drug, TH-302, for the front line treatment of
pancreatic cancer. Hypoxic regions of tumors are areas where oxygen
is deprived. Most drugs have a hard time circulating in such
environments. TH-302 actually prefers such an environment. Equally
important, the drug leaves healthy tissue alone.

Right now, Threshold is focusing on pancreatic cancer, but the
technology could be applied to many other types of tumors. TH-302
is still at least three years away from commercial launch. It has
shown clear efficacy in the first two phases of clinical testing
(though Phase II testing continues), but the all-important Phase
III trials are yet to come.

In coming quarters, the stock could get a lift from further solid
clinical testing data as well as deeper Wall Street coverage. The
company recently appointed Dr. Samuel Sachs as interim chief
medical officer. Sachs, who co-founded
Jazz Pharmaceuticals (Nasdaq:
JAZZ
)
, has deep ties to Wall Street. As TH-302 progresses through
clinical trials, Threshold may seek to partner with a large drug
firm. It's hard to peg the size of a potential market opportunity,
but it could be significant, well above the company's current $90
million market value.

Medium risk

2. Intermune (Nasdaq:
ITMN
)
This biotech stock really caught fire last December when it
received preliminary European approval for Esbriet, which treats
pulmonary cystic fibrosis. The stock doubled on December 17, 2010
to around $35 before hitting almost $50 in early April 2011. At the
time, investors were buzzing that Intermune would benefit from
either a
buyout
or an eventual approval for Esbriet in the United States as well
(where it has undergone greater regulatory scrutiny). Momentum
investors soon lost patience and
shares
are back down in the mid-$30s.

The previous move toward the $50 mark was no coincidence. Analysts
thought this would be a price offered by a potential suitor. "An
opportunistic offer of $50 or more is almost a no-brainer for
(companies like
Merck (NYSE:
MRK
) and Astra-Zeneca (NYSE:
AZN
)
)," wrote analyst Alex To at CrossCurrent Research in a late
December research note.

Perhaps the most likely suitor would have been
Gilead Sciences (Nasdaq:
GILD
)
, which decided in December that its own drug to treat idiopathic
pulmonary fibrosis (
IPF
) was ineffective in clinical trials. But Gilead decided to acquire
Arresto Biosciences, which has an IPF drug in an earlier stage of
clinical testing.

I've seen this play out elsewhere. Biotech firms with
newly-approved drugs seeking to sell themselves can see shares
sizzle. But when no suitor emerges, the stock can lose all of its
gains -- and more. This is also the case with
Savient Pharmaceuticals (Nasdaq:
SVNT
)
, which has lost two-thirds of its value from its peak.

Just because buyers fail to emerge for companies like InterMune and
Savient right away doesn'tmean they don't hold real appeal. Big
drug companies absolutely need newly-approved promising drugs for
their pipeline. They just move too slowly to please the buyout
crowd. Both Intermune and Savient, nicely down from their highs,
provide a window of opportunity. Buyout or not, Intermune's
fortunes should rise in earnest as European sales begin later this
year, with potential U.S. sales coming in a few years.

Low-to-medium risk with solid upside

3. Ligand Pharma (Nasdaq; LGND)
Rather than develop its own drugs, Ligand invests in other biotech
firms, generating income from milestone payments and royalties that
small firms get from their Big Pharma partners. Ligand likes to
focus on early-stage firms needing cash and possessing considerable
upside.

Right now, Ligand has a hand in more than 50 companies, about
half of which have already progressed their drugs to Phase II
clinical trials or beyond.

Jeffrey Cohen, who follows Ligand for C.K. Cooper (and for full
disclosure is a friend and former of mine) thinks shares are worth
$21 on a sum-of-the-parts basis, including projected royalties,
milestone payments and the stakes in various firms that have not
yet garnered revenue streams. This target price is nearly double
the current value. Analysts at McNicoll, Lewis and Vlak are even
more bullish with a $30 price target. "We view LGND as a more
de-risked biopharma investment with an unprecedented number of
individual shots on goal," they recently wrote.

Low-risk

4. Celgene (Nasdaq:
CELG
)
With more than $4 billion in annual sales, this is a mature biotech
company continuing to pound out impressive sales for its myeloma
drug, Revlimid.

In recent years, management has been pursuing other drugs in
clinical testing to prepare for the day Revlimid loses its patent
protection. This won't be for at least another five years, however.
As Celgene's other drugs gain traction, sales and profits are on
the rise, projected to climb another 20% to 25% this year and 15%
in 2012. Meanwhile, shares have flat-lined around $60 for the past
five years after a stunning upward move in the prior five years.
Trading at just 15 times projected 2012 profits, this is a
reasonably valued growth vehicle in a volatile industry.

Action to Take -->
Taken together, these stocks represent a nicely diversified
approach that could raise your portfolio higher even if the market
and broader
economy
fail to gain traction in the quarters ahead.

-- David Sterman

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Disclosure: Neither David Sterman nor StreetAuthority, LLC hold
positions in any securities mentioned in this article.